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The Reserve Bank of India's (RBI) moves last week to tighten money supply may hit construction and have a squeezing impact on economic growth. However, the economy stopped on its track to repeat 9 per cent growth in the fiscal year that began on Sunday may yet sustain a growth rate of 8 to 8.5 per cent, experts said.

A lot would depend on whether foreign direct investment (FDI) inflows would make up for a shortfall in domestic investment, after the RBI raised the share of cash that banks must park with it from their deposits and also put up its short-term lending rates for banks, they said on Monday, as stocks plunged amid fears of a growth slowdown.

Analysts tracking the developments said that the balance of payments data released on Friday showed a "comfortable" external position. 

"There are a few points that merit being highlighted in the current context. First, despite a slowing down in the US economy in the same quarter (October to December 2006) to 2.5 per cent from 3.5 per cent, services export remain strong. Moreover, even while portfolio investments into India have been erratic over the last fiscal year (2006-07), FDI flows are strengthening. The third quarter numbers suggests that flows to India are likely to remain robust despite softness elsewhere," said an economist at Edelweiss Securities.

However, this in turn may lead to an appreciation in the exchange rate, which the RBI may not be comfortable with, he added.

The Federation of Indian Chambers of Commerce and Industry (FICCI) said that there was a danger of the economy moving into a negative cycle due to stagnant demand, particularly in construction.

"Any adverse impact on housing growth could have a serious impact on the overall economic growth. The construction boom is limited only to the metros and big cities and this cannot be the parameter for the RBI to make the loan price dearer," said the industry chamber, after lenders moved to raise home loan rates at the weekend.

While the repo-rate has been hiked by 0.25 percentage points to 7.75 per cent with immediate effect, the CRR (cash reserve ratio) has been hiked by 0.50 per cent in two stages of 0.25 per cent each to 6.5 per cent. The first hike will come into effect from April 14 and the next hike from April 28.

Both the moves are aimed at tightening liquidity.

Economists felt that CRR is likely to remain the RBI's preferred instrument of monetary tightening. "Further tightening will depend on external flows. Barring further tightening by the RBI, growth is likely to sustain at 8 to 8.5 per cent as opposed to 9 per cent in current fiscal year," said a Delhi-based economist, who did not wish to be identified.

The rupee has appreciated to an almost eight year of Rs 43.03 to a dollar and economists felt that the rapid build-up in foreign exchange reserves over the last quarter may have been responsible for this. The foreign exchange reserves currently stand at around $198 billion with an average of $1.8 billion added every week. That strengthens the money supply in the system, which can keep loans flowing, though it is not certain what will happen to lending rates at which they can be taken.

Email author: gaurav.choudhury@hindustantimes.com